Washington has so thoroughly botched its supervision of the banking industry that 200 banks are likely to fail this year — easily surpassing last year’s 140 bank failures … inevitably involving the greatest bank losses in history … and already costing the FDIC ten times more than the great S&L and banking crisis of the 1980s did.

I am not basing these conclusions on conjecture. They come straight from official sources. Specifically …

She slammed virtually all of Washington for allowing banks to establish a huge, high-risk “shadow banking system.”

And she made it abundantly clear that, without sweeping, far-reaching reforms, we risk another devastating debt crisis.

Each of her conclusions is abundantly obvious and thoroughly documented. What she did not mention, however, are the following equally obvious facts:

Obvious fact #1. The Fed under Bernanke is now pursuing an even more stimulative, lower interest rate policy than it did under Greenspan, threatening to create even larger bubbles and more devastating busts …

Obvious fact #2. In just the last two years, between bank bailouts and easy money, Washington has done more to encourage the growth of the shadow banking system than in all previous years combined, and …

Obvious fact #3. Despite all the talk and testimony, the nation’s powerful banking lobby virtually guarantees that, in the absence of another Wall Street meltdown, the chance of sweeping reforms is virtually nil.

So here’s America’s financial dilemma in a nutshell:

Without sweeping reforms, the nation is doomed to repeat history with another debt disaster. But without another debt disaster, the nation’s political will for sweeping reforms is dead or dying.

In the meantime, the aftershocks of the 2008 debt crisis are getting worse, as the latest news clearly illustrates …

171 actual total failures: In addition to the 140 banks and S&Ls that failed in 2009, 31 credit unions went under, bringing the total tally to 171.

Worse than the 1980s: If you’re among those who think today’s banking crisis isn’t nearly as bad as the great S&L and banking crisis of the 1980s, think again. The average bank failing today is six times larger than it was back then, producing far greater losses. Moreover, each bank failure is costing the FDIC about TEN times more than it did in the 1980s crisis, according to the Meridian Group of Seattle. As a result …

Worst FDIC losses of all time: The FDIC lost more money in bank failures ($36 billion) than it lost in the ENTIRE five-year banking crisis from 1987 through 1992 ($29.6 billion). And in 2010, with the number of failures likely to increase, the losses will be even larger.

Big banks still losing billions with consumers: Until last week, the consensus opinion on Wall Street was that the troubles at the BIG banks were over; that to close this chapter in history, the only task remaining was a mop-up operation at smaller regional and community banks around the country.

That theory was shattered on Friday when JPMorgan Chase revealed it was forced to add $1.5 billion to its consumer loan loss reserves. The big problem: When it took over Washington Mutual last year, the biggest failed S&L of all time, it inherited a cesspool of mortgages that are now going bad at an accelerating pace. Other big consumer banks — like Citigroup and Bank of America — likely face similar woes.

The trading profits of big investment banks are a bubble: What most Wall Street bank analysts still don’t seem to recognize is that the giant trading profits they’ve been so enthusiastic about are generated by the same low-interest Fed policy that created the housing bubble — and is now in the process of creating MORE bubbles.

Without the Fed’s largesse, without the low-cost financing, and without the big risk appetite it generates, most of the big bank trading profits would have been impossible. More to the point: Just as soon as the Fed finally executes an exit plan, the bulk of those profits are likely to turn to losses.

What To Do

First and foremost, do not let up your guard when it comes to keeping your money safe. Yes, I know. With all the talk of the “end” to the crisis and Treasury bills paying virtually nothing, it’s tempting to venture away from safe harbors.

But how much more yield can you get by doing so? If you switch from Treasury bills to bank CDs, for example, the most you can gain is a small fraction of a percent. And if you switch from bank CDs to low-rated corporate debt, the extra yield you get is even less attractive.

In sum …

At this early stage so soon after the worst debt crisis since the Great Depression, the TRUE RISK of putting your money in higher yielding savings vehicles is still very high. Nevertheless, banks and other borrowers are asking you to take that risk WITHOUT paying you more than pennies for it.

My recommendation: Tell them to go fly a kite!

For your keep-safe funds, use strictly short-term Treasuries or equivalent.

Second, if you do other business with a bank or if you still want to keep some part of your savings in bank CDs … at least be sure to avoid the banks most likely to fail and stick with the ones most likely to survive. (For the latest Weiss Lists of the weakest banks and S&Ls, click here. For the strongest, click here.)

Third, bear in mind that, when it comes to your investment decision-making, TIMING is everything.

Last year, the stepped-up pace of bank failures did not derail the weak-but-continuing recovery in the U.S. economy. And for now, that’s bound to remain the case. As soon as we see signs that’s about to change, we’ll do our best to alert you. Until then, we stick with our current posture: Continue to invest, but do so with great caution.

Money and Markets (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Nilus Mattive, Claus Vogt, Ron Rowland, Michael Larson and Bryan Rich. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM, nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical in as much as we do not track the actual prices investors pay or receive. Regular contributors and staff include Kristen Adams, Andrea Baumwald, John Burke, Marci Campbell, Amy Carlino, Selene Ceballo, Amber Dakar, Dinesh Kalera, Red Morgan, Maryellen Murphy, Jennifer Newman-Amos, Adam Shafer, Julie Trudeau, Jill Umiker, Leslie Underwood and Michelle Zausnig.

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